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Weekly UpdatesThe implication of the Passengers variable is not as straightforward. As outlined above, passenger traffic has both demand and cost side effects on price. From the cost side, an increase in passengers can raise densities on a route leading to cost economies and lower prices.(20) From the demand side, a surge in traffic can lead to increases in price. The net effect of the Passengers variable on price is indeterminate. The statistically insignificant coefficient for Passengers in Model 2 does not, therefore, necessarily imply that passenger traffic has no effect on price, but may imply that the positive and negative effects are in balance. The inclusion of the firm dummy variables in Model 2 controls for firm-specific cost differences. As a result, the coefficient on Passengers in Model 2 is more likely to represent shifts of the demand curve. Its small positive sign is consistent with a relatively flat Supply (marginal cost) curve.
The dummy variables for the carriers from Model 2 also produce interesting results. The entry of two of the three largest carriers onto a route, American and Delta, cannot be expected to lead to significantly lower prices, while the addition of United Airlines, the other "big three" carrier, should reduce one-way fares, on average, by about $15. On the other hand, the entry of Southwest Airlines onto a route reduces average fares for all carriers on a route by almost $70. Given that the mean fare in our sample is $136 (see Table 1), this represents a 51 percent reduction in fares and approximates the 48 percent reduction reported in the time series analysis section of this article. Other "low cost" carriers, such as Morris (recently purchased by Southwest), Valuejet, and Reno, also result in significantly lower fares upon entry.
CONCLUSIONS AND POLICY IMPLICATIONS
Two questions were posed at the beginning of this article. First, how different is the effect of the low cost carriers' entry on routes, from the entry of other carriers? Second, are the price and traffic effects of new entrants, both low cost and other carriers, sustained past the initial promotional period or are they merely promotional? These questions were first addressed with a descriptive analysis using data over a three-year time period from 1991 to 1994. The results were illustrated in Figures 1 to 4. The figures clearly illustrated that the entry of low cost carrier Southwest on a route had a differential impact from the entry of other carriers, on average. These results are in agreement with earlier studies on low cost carriers by Bailey, Graham, and Kaplan(21) and Strassmann(22) and with the study on Southwest by Bennett and Craun.(23) The entry of Southwest resulted in a significantly greater price reduction and increase in traffic. Both of these impacts were sustained over a one-year period after route entry. The entry of established carriers, such as United, American, and Delta, appeared to have little or no effect on prices and passenger traffic. In addition, it was shown that the routes entered by Southwest were markedly different from the routes entered by pre-deregulation carriers. Southwest tended to enter shorter routes with a higher level of concentration and a lower level of passenger traffic.
Two regression models were estimated to determine the impact of cost, demand, market structure, and carrier presence variables on prices. The first model contained no carrier dummy variables, while the second model had a system of carrier dummies. The results indicate that route concentration and route density are not significant determinants of price on a route when carrier-specific effects are considered. In our second model, with the carrier dummies, the presence of low cost carriers significantly lowered prices on routes, while the route concentration and route density variables had insignificant impacts on price.
At least two policy implications can be derived from these results: First, public policy should encourage the expansion of low cost carriers. Their presence on routes leads to significantly lower prices than does the presence of other carriers. As an example of public policy designed to support the low cost carriers, airport operating authorities can ensure gate and slot availability to these carriers through either airport expansion or by using a competitive bidding process for available gates and slots.
Second, research results indicate that no public policy initiative is currently required to increase competition on routes currently dominated by low cost carriers, such as Southwest. The fear raised by Bennett and Craun(24) of the U.S. Department of Transportation that Southwest would raise prices after establishing dominance on a route does not, as yet, appear to be realized. Market concentration is not a significant determinant of prices on U.S. domestic routes. A highly concentrated route, served by Southwest, has significantly lower prices than a less concentrated route served by two or three higher cost carriers.
ENDNOTES
1 See Shakira Hightower, "Southwest Airlines to Initiate Service to Baltimore with Discounted Fares," Wall Street Journal, July 15, 1993.
2 Ibid.
3 James Ott, "Southwest Enters East Coast Market," Aviation Week & Space Technology, July 19, 1993, p. 26.
4 Randall D. Bennett and James M. Craun, "The Airline Deregulation Evolution Continues: The Southwest Effect," U.S. Department of Transportation, Office of Aviation Analysis, Washington, D.C., 1993.
5 Papers in this stream, not discussed below, include: Thomas Gale Moore, "U.S. Airline Deregulation: Its Effects on Passengers, Capital, and Labor," Journal of Law and Economics, Vol. 29, April 1986, pp. 1-28; Severin Borenstein, "Hubs and High Fares: Dominance and Market Power in the U.S. Airline Industry," Rand Journal of Economics, Vol. 20(3), Autumn 1989, pp. 344-365; Gloria J. Hurdle, et. al., "Concentration, Potential Entry, and Performance in the Airline Industry," The Journal of Industrial Economics, Vol. 38(2), December 1989, pp. 119-139; Steven Morrison and Clifford Winston, "Enhancing the Performance of the Deregulated Air Transportation System," Brookings Papers: Microeconomics 1989, pp. 61-123; Steven T. Berry, "Airport Presence as Product Differentiation," American Economic Review, Vol. 80(2), May 1990, pp. 394-399; U.S. General Accounting Office, Airline Competition: Effects of Airline Market Concentration and Barriers to Entry on Airfares, Washington D.C.: General Accounting Office, 1991; and Margaret A. Peteraf and Randal Reed, "Pricing and Performance in Monopoly Airline Markets," Journal of Law and Economics, Vol. 37, April 1994, pp. 193-213.
6 In both of these cases, it was conjectured that the newly certified carriers had lower cost structures than existing carriers.
7 Elizabeth E. Bailey, David R. Graham, and Daniel P. Kaplan, Deregulating the Airlines, Cambridge, MA: The MIT Press, 1985.
8 Diana L. Strassmann, "Potential Competition in the Deregulated Airlines," The Review of Economics and Statistics, Vol. 72, 1990, pp. 696-702.
9 Michael D. Whinston and Scott C. Collins, "Entry and Competitive Structure in Deregulated Airline Markets: An Event Study Analysis of People Express," Rand Journal of Economics, Vol. 23(4), Winter 1992, pp. 445-462.
10 Randall D. Bennett and James M. Craun, "The Airline Deregulation Evolution Continues: The Southwest Effect," 1993.
11 Income and population data were gathered from U.S. Department of Commerce, Survey of Current Business, Volume 72(4), April 1992; and U.S. Department of Commerce, Local Area Personal Income 1962-1992, Department of Commerce, Economics and Statistics Administration, Bureau of Economics, 1994. These data were used in the instrumental variable estimation described in the next section of the article. Stage length data were drawn from the Official Airline Guide, North American Edition, January 1994.
12 The Herfindahl Index is a measure of market concentration and takes into account both the number of competitors and the market share of each competitor. An index value of 10,000 would imply market monopolization. An index value of 5,000 could be derived from a market with two competitors, each with a 50 percent market share. The Herfindahl Index would rise to 6,250 in a two competitor market with one competitor holding a 75 percent market share and the other only 25 percent. The Herfindahl Index will approach 0 as the number of competitors in a market approaches infinity and the share of all competitors approaches equality.
13 In order to be considered an entrant on a route in a given quarter, a carrier had to meet a two-part test. First, it had to have less than a 5 percent market share the previous quarter. Second, it had to increase its market share by at least five percentage points. No entry information is provided for the third quarter of 1991, since data were not collected for the previous quarter and, given the two-part test, entry could not be determined.
14 In order to be considered to have exited a route in a given quarter, a carrier had to meet a two-part test. First, it had to have more than a 5 percent market share the previous quarter. Second, it had to decrease its market share by at least five percentage points.
15 If one takes account of the generally upward trend in passenger traffic over this time period, the change in passenger traffic on routes where pre-deregulation carriers entered is even smaller.
16 For the case of a passenger buying a round-trip ticket, the fare was divided by two to produce a one-way fare. Only revenue passengers were included in the sample. Frequent flier tickets and other zero fares were excluded from the sample.
17 The total is for origin and destination passengers. For example, if there were 50,000 passengers who flew from New York to Chicago in a quarter and 55,000 who flew the other way, the passenger total used would be 105,000.
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